Chapter 3 - Regulation

Question 1

What are the Aims of regulation?

Answer 1

• Limit the likelihood of failures
• Limit the potential cost of failure
• Limit the need to step in as lender of last resort

Question 2

What are the principal Aims of regulation?

Answer 2

• Correct perceived inefficiencies
• Protect consumers
• Maintain trust
• Reduce financial crime

Question 3

Describe the costs around regulation?

Answer 3

• Regulation has a cost
• Achieve their aims at minimum cost and hope that benefits outweigh the cost
• Direct and Indirect costs

Question 4

What are the functions of a regulator?

Answer 4

• Influence and review government policies
• vetting and registration of firms and individuals
• Supervising prudential management
• Supervising market conduct and taking enforcement where needed
• Enforcing regulation, investigate suspected breaches, imposing sanctions
• Providing information to consumers and the public

Question 5

What is the need for regulation?

Answer 5

• Need is greater in Financial Markets than other markets
• Confidence
• Asymmetric Information

Question 6

Why is confidence in the Financial Market important?

Answer 6

• There is a danger of problems in one area spreading to another
• The damage done by a systemic financial collapse
• Ensure failure of one participant doesn’t threaten the whole system

Question 7

What is Asymmetric Information?

Answer 7

• When at least one party has relevant information that the other party or parties do not have

Question 8

What is Anti-Selection?

Answer 8

• More likely to take out a policy if the person believes their risk is higher than what was priced for

Question 9

What is Moral - Hazard?

Answer 9

• The action of a party that behaves differently to what they normally would if they were fully exposed to the consequences
• Leaving the origination to bear the consequences of the action

Question 10

Why is Information asymmetry important to regulators?

Answer 10

• Information asymmetry between the product provider and end customer
• ie. A bank gains at the expense of the consumers through complex pricing
• There exists a difference in expertise and negotiating strength in financial transactions - retail markets
• Insurance, Investment and Pensions can have a significant impact on future economic welfare of individuals

Question 11

How can a regulator deal with Information Asymmetry?

Answer 11

• Disclose information in plain language
• Chinese Walls (for conflicts)
• cooling-off periods
• customer legislation on unfair contract terms and TCF
• ‘Whistle Blowing’

Question 12

How can a regulator ensure confidence is maintained?

Answer 12

• Checks on Capital Adequacy of providers
• ensure practitioners are competent and act with integrity
• industry compensation schemes
• ensuring orderly and transparent markets
• stock exchange requirements

Question 13

Outline the different forms of Regulation?

Answer 13

• Prescriptive through rules
• Freedom of action with rules in publicity
• Outcome Based - Freedom of Action but set outcomes

Question 14

Challenges with Statutory regulation?

Question 15

What roles do major FIs play?

Answer 15

• Central Bank - controlling/influencing economic variables - acting as lender of last resort
• State Intervention - Provision of products (through state monopoly companies), control of premiums
• Large Market Participants - influence premium rates, allow smaller participants to find niche markets, distort market and may use to much regulatory resources

Question 16

What regulations are being considered to address climate change?

Answer 16

• consider climate risk in business decisions and strategy
• effectively disclose and report on climate related risks and opportunities
• adopt a consistent and reliable means of assessing, pricing and managing climate based risks
• incorporate environmental, social and governance (ESG) factors into investment management decisions
• incorporate financial risks from climate change into existing risk management processes
• use scenario analysis to inform risk identification and estimate the impact of financial risk arising from climate change
• consider impact of climate risks on ability to meet obligations towards policyholders and other key stakeholders